Mortgage applications

You will find a series of tasks to complete at the end of this unit. It’s up to you whether you complete them without reference to the information or refer back – you know best the way you learn.

Please bear in mind that these exercises are designed to get you thinking and to help you clarify key points you have learned. They are not an indication of the questions that may be asked in the CeMAP® examination, and many other areas of the manual will be tested as well. It is important that you read and understand the entire text – don’t rely on the exercises as your sole method of study.

Section 1

The role of the mortgage adviser

The mortgage market is often baffling for the average potential purchaser. Few people understand the complexities of the purchasing process, the mortgages available and the importance of choosing the most appropriate repayment method. This is where the mortgage adviser comes into the equation; he can inform and guide the customer towards the most suitable mortgage for his needs.

Advisers are expected to give ethical advice, which means asking appropriate questions to ascertain the customer’s attitudes and needs, to identify the customer’s full financial situation, verify information where possible and offer advice and recommendations that best suit the customer. The customer’s best interests should always be at the forefront of any advice or recommendations given.

The adviser’s exact role depends on the level of service to be offered. The customer can be offered an ‘advised sale’, where the adviser selects the most appropriate mortgage product to suit the customer’s needs and makes a personal recommendation. Alternatively, the customer can be given information about specific products that meet his requirements. No recommendation is given and the decision rests with the customer. For the purposes of this section we will focus on the advised sale.

There are three levels of service that the adviser can offer to customers. The service to be provided must be clearly indicated to the customer when first making contact. The three levels are:

The adviser must first interview the customer to find out as much relevant information as possible. In most cases the adviser will need to explain terminology, products and procedures so that the customer can give reasoned and informed answers. Among other things, the interview will include establishing:

We will look now in detail at the key elements of this information.

The adviser must ensure, as far as possible, that the customer will be able to afford any solution that is recommended. If a borrower takes on a mortgage that he cannot afford and on which he cannot keep up repayments, there is a danger that the property will be repossessed or, at best, he will have to sell. A number of key issues should be covered.

Once the information has been gathered, steps should be taken to verify its accuracy; this is particularly the case with income. The adviser should establish a breakdown of income – basic salary, bonuses and overtime, including whether or not it is guaranteed. As you will be aware, irregular or non-guaranteed income might not be taken into account by a lender, or a proportion might be included. This information can be seen on payslips, while total income will be shown on the individual’s P60. Self-employed individuals often have more difficulty proving income. Lenders will require evidence, including the time the business has been running and profit and loss records for the last three years; where the business is new, the customer’s previous career record will be relevant. There could be a temptation on the part of the self-employed customer to choose a self-certified mortgage, where he declares his income but no evidence is required. While this can be appropriate for those who have trouble providing evidence, it is tempting to overstate income in order to secure a bigger mortgage. This is both illegal and dangerous, and the adviser should warn the customer of the consequences of such action; the customer could end up with a mortgage he cannot afford, and falsifying income, even on a self-certification basis, is fraud, punishable by law.

When advising a customer, the adviser should recommend the most suitable mortgage for the customer’s circumstances. The following issues will need to be considered in assessing suitability:

The customer’s attitude to, and awareness of, risk is another important consideration. In mortgage terms, risk can be:

In general terms, any mortgage should be arranged over the shortest possible term. People generally dislike debt and would like to be mortgage free at the earliest opportunity. In terms of time, the key considerations would be:

Once the adviser has gathered the relevant information, he will be well placed to provide the customer with well-founded, ethical advice and help him to cut through the potential minefield that is the mortgage market.

The mortgage adviser has a great deal of responsibility, as his advice will result in the client taking on a long-term commitment. Getting it wrong could cause major problems and distress for the customer. It is even more important now that mortgages and mortgage advice are fully regulated by the FSA that an adviser takes all the necessary steps to ensure that he is fully aware of his client’s circumstances, needs and objectives before giving advice and recommending a suitable product. It is also important to establish the client’s attitude to risk, as clearly some mortgage products do involve a greater element of risk than others. For instance, the uncertainty of how future interest rate movements will affect the monthly payments on a capped or discounted mortgage against the certainty provided by a fixed rate product.

Having collected all the relevant facts about the client, the adviser must then be able to show clearly how the product that is being recommended meets the client’s precise needs and objectives. This must be explained in language that can be easily understood by the client, without the unnecessary use of technical jargon. It is vital that the client fully understands why the product is being recommended and that any questions or any concerns he has are properly addressed.

Ethical advice is a simple concept. It means giving advice based on what is best for the customer in view of information known at the time, regardless of the needs of the adviser. For example, the adviser should not be influenced by commission or bonus payments he might receive for selling certain products.

The FSA has encapsulated ethical advice in its ‘Treating Customers Fairly’ (TCF) initiative, which focuses on one of the FSA’s Principles for Business:

The concept of treating customers fairly is central to the FSA’s principles, and is a key element of one of the objectives - securing an appropriate level of protection for consumers. However, the reality is that the FSA has limited ability to deliver ‘fairness’ through regulation. The concept of fairness will differ from product to product, customer to customer and service to service. As a result, it would be very difficult to produce rules to cover all eventualities without stifling the ability of firms to operate efficiently. The FSA is concerned that even more regulation would stifle the market and lead to many companies focusing on meeting the regulations rather than providing quality to customers. This, in turn, would increase costs and reduce the range of products available.

As a result, the FSA has recognised this challenge and has taken steps to address TCF, by putting measures in place to:

In many cases the measures seek to improve or clarify what is already in place, rather than develop new rules. The FSA is also working with firms, and industry and consumer groups to develop best practice guidelines. Future FSA supervision will consider how well firms meet the principles of treating customers fairly.

Arrears are dealt with in detail in Unit 6, and should be seen as a specialist area. However, it is worth a brief mention here, as advisers may become involved in the initial discussions with customers with problems.

People have differing attitudes to debt and debt repayment. There are those who take the responsibility seriously and will take any realistic action to make payments on time. Even these individuals will sometimes fall behind with their payments, through no fault of their own. Those who do fall into arrears should be encouraged to seek advice at the earliest opportunity, as speedy action can reduce the potential arrears and put them on the road to recovery. Delaying action is likely to result in increased arrears and a more serious problem. In this situation they have a number of options available to them, depending on the extent of the problem, including:

There are also, of course, those who do not seem to take debt seriously. Some borrowers in arrears appear happy to ‘hand back the keys’ and move on. Others see bankruptcy as an option.

Those who feel this is an option should be warned that:

There are some who feel bankruptcy will solve their problems. Indeed, for those in serious debt, it could be a viable solution if there is no other way of settling the debt. For the majority of debtors, however, there are potential problems:

Bankruptcy should be seen as an absolute last resort, and customers should be advised to pursue all other avenues before contemplating such a serious step.

Section 2

Assessment of status

Although the principles of lending are common to all institutions, the procedures and documentation differ widely. You should try to obtain a copy of a mortgage application form and other standard documentation in order to draw practical relevance from this section.

Once a potential mortgage customer has decided to go ahead with an application, all lending institutions start off the process of loan assessment by asking for an application form to be completed. Although there are as many different application forms as lenders, the principles underlying the collection of information are common to all.

The application form can be completed by the applicant or by a telesales operative who collects details from the customer over the telephone. In either case, the applicant should be encouraged to submit correct and unambiguous information that requires minimum effort to corroborate it.

When completing a mortgage application form in the branch office, it is possible for the mortgage adviser to talk through each section, clarifying any requirements where necessary. It is more difficult to check for accuracy over the telephone, so the lender will send out the form not only to have it signed but also to get the applicant to check the information entered into the system.

The application form normally requires the following information.

Current permanent address and a contact address if different. If the place of abode has changed in the last three years, a previous address may be required also.

The lender must also find out the basis of occupation of the current property – are the applicants renting or living with parents, for example?

It is illegal to discriminate on the grounds of nationality or race, but many lenders specify that mortgage business can only be accepted on normal terms if the borrower is resident in the UK. This is for control purposes – in the event of mortgage loss it can be difficult to sue a non-resident. Most lenders will consider loans to non-residents but with specific conditions attached.

This information gives the lender a ‘pen picture’ of the client’s family situation. More important, it confirms the ages of dependants. If any are aged 17 or over and they are not to be party to the mortgage, it is necessary to obtain a ‘consent to mortgage’ form so that an overriding interest under section 70 of the Land Registration Act 1925 is not created (England and Wales only).

While it is only people aged 18 or over who could have an overriding interest, lenders generally collect details of people who are 17 or over at the time of the mortgage application, to ensure they have details of everyone who will be 18 at the time of completion.

Some lenders choose not to obtain these consent forms but obtain insurance cover to protect them against any potential losses.

The following details are required for each person wishing to be a party to the mortgage:

The lender has to form a subjective judgment about the quality of income and employment. If the applicant works for a company that has been laying off thousands of workers, it is in the interest of both the lender and the borrower to determine how safe and permanent the employment actually is. It cannot be assumed that the person is going to be made redundant – the applicant’s job may be safer than the mortgage adviser’s! Nevertheless, the right questions have to be asked so that a borrowing commitment that will be regretted is not taken on board.

Conversely, some of the jobs that have historically been the safest of all may be in jeopardy. In the past 20 years, there has been a fundamental change in the ranks of those structurally unemployed, away from blue collar, labour intensive industries towards white collar, middle management professions. This is evident in a wide range of occupations, including the financial sector. One outplacement consultancy recently stated that the stereotype of its typical customer is ‘35–45 years old, white collar, middle management, male, married with children, 20 years in the same firm’.

Income details have to separate basic earnings from other forms of income. A person earning £300 per week, for example, may be on a basic salary of one-third of that, with the difference made up of sales-related bonuses and commissions. If bonuses and commissions are to be considered, a conservative view should be taken. The purpose is not to prevent the person from obtaining the size of loan required, but to ensure that the mortgage payments are affordable.

Most mortgage application forms, therefore, have separate lines or boxes to be completed for basic earnings (specifying gross or net), regular salary top-ups (such as Christmas bonuses), overtime, bonuses, commissions and other sources of income.

Where sales-related income is taken into consideration, many lenders take an average of income from this source over a stated number of years (for example, three years).

If the applicant is self-employed, the lender will require:

Details of the business of the self-employed person have to be carefully recorded. Take the word ‘income’ for example. This can mean:

Most mortgage application forms are inadequate for the purpose of forming a judgment on the financial position of the business. This is not down to inadequacy of form design – there are simply too many types of business to consider, each with their own idiosyncrasies.

Invariably, therefore, the lender has to collect supplementary information from the self-employed applicant. Well-run businesses have a business plan which sets down essential details of the operation, including financial information (historic and projections for the future), markets and other vital details. These should be supported by financial statements as mentioned above. Most lenders insist that the profit and loss account and balance sheet for each of the last three years be submitted to give a trend in business performance. These are only useful if prepared and ratified by a professional accountant. For smaller businesses they are unlikely to have been audited, though most accountants insist that they have sight of bank statements for the relevant periods before they will sign the accounts.

Projections are accepted by some lenders as an indicator of future business. Most often, these are based on the entrepreneur’s own perception of the future order book, even if signed off or prepared by an accountant. They are therefore of extremely limited value.

Information on all outgoings is required:

The significance of the information in this section of the application form is that it forms the basis of credit assessment. Many lenders now run the information collected through a credit scoring system in order to eliminate the ‘no hope’ cases as well as to indicate the likely degree of risk.

The lender will require:

The property details are invariably checked when a valuer is sent out to assess the property.

When the application is made through a local branch office, it should be possible for the lender to form a judgment about the quality of the property, the area in which it is located and whether the value is in line with other similar properties in the area. This is especially important when the applicants are moving into an area for the first time and may be in danger of paying ‘over the odds’ because they have a limited knowledge of local market conditions.

For corporate and semi-corporate applications, the lender will wish to know the source from which loan repayments will be made. Ideally this should come from cash flow generated by the business.

All application forms have a declaration to be signed and dated by all applicants. This states that the information given is correct to the best of their knowledge. It also authorises the lender to make all necessary enquiries relevant to the application and warns the applicant that appropriate action will be taken, including referring the case to the police, if it is believed that information given has been used deliberately to defraud the lender.

Owing to the increase in fraud in recent years, the courts now take a serious view of offences in relation to applications for loans. It is not unusual for custodial sentences to be imposed for even first offences.

The application may contain a statement as to non-warranty regarding the purchase price or property condition. This means that the lender is saying that the price seems reasonable but it can’t guarantee that this is the case, and that it cannot give any guarantee as to the condition of the property.

Many lenders accept applications through the traditional channels of branches, agencies and intermediaries as well as centralised telesales units (or call centres). When face-to-face contact is possible, it is better for the application to be completed by the applicants themselves, with appropriate guidance given at each stage. In the latter case, the lender usually completes the form on screen from information given over the telephone. This is then confirmed by sending a computer-generated form by post to be signed and dated by the applicant.

Advisers should be aware of the need for the form to be completed accurately and truthfully in all cases. Although they are in a selling role, they should also be prepared to make appropriate cautionary comments if it is believed that the applicants are being less than honest.

Many lenders use standard interview structures in order to complete the application process in a logical manner. One example used by several banks is the CAMPARI acronym. The abbreviation represents: Character, Ability, Margin, Purpose, Amount, Repayment and Insurance.

Each lender has its own system here. A good practice for the purpose of your study is to compare the above text with your own institution’s application form and interview/assessment methodology.

As mentioned in Section 1, lenders normally base the borrowing capability of those in PAYE employment on a multiple of gross annual income of the main borrower, sometimes taking a secondary income into account.

One example might be main income multiplied by three, plus all secondary income.

The origin of the income multiple approach lies in the 1950s when it was common to use a multiple which would result in a loan requiring no more than one-third of disposable income to service it. This is rather too simplistic today.

Even if discretion is permitted by the lender, income criteria must be applied sensibly at all times. The purpose is not to put rules in place for the sake of it, but to ensure that the borrower has every chance of being able to afford the monthly payments.

The purpose of the income multiple is to ensure that there is a realistic proposition that the borrower can meet the repayments. It does no one any good to advance funds which cannot be repaid, least of all the borrower. Lenders do, however, adopt a flexible approach when it is felt that the borrower has exceptional circumstances. For example:

In addition to basic income, many applicants have supplementary income such as:

The lending institution must evaluate the volatility or otherwise of such income before it is considered ‘permanent’ or ‘guaranteed’.

The following is an example of the use of income multiples in determining borrowing capability.

Mr Conway earns a basic salary of £18,000 pa and his wife’s guaranteed salary is £24,000. As a salesman, Mr Conway usually receives a performance-related annual bonus. There is no guarantee that this will be paid but in the past three years he has received £8,000, £4,000 and £6,000 respectively. Mrs Conway also receives an annual income of £5,000 from a lifetime trust.

A typical lender might employ the following income multiples:

3 x main income + 1 x secondary income

or

2.75 x joint income

As far as Mr Conway’s annual bonus is concerned, a sensible approach would be to take the average over the past three years and add this to his guaranteed basic salary. His income for mortgage purposes is therefore:

£18,000

£18,000 + –––––––––– = £24,000

3

The trust income that Mrs Conway receives is guaranteed for life and can therefore be added to her basic salary. Her income for mortgage purposes is £29,000.

The maximum amount that Mr and Mrs Conway could expect to borrow would be the higher of:

(3 x £29,000) + £24,000 = £111,000

and

2.75 x (£29,000 + £24,000) = £145,750

A loan of £145,750 would, of course, be subject to confirmation of the stated incomes and a satisfactory valuation of the property they decide to purchase.

Compare the worked example above with your own institution’s approach.

Note that the example refers to ‘higher and lower’ incomes, rather than ‘male and female’ incomes. It is unlawful to discriminate on the grounds of sex under the provisions of the Sex Discrimination Act 1970. Likewise, the lender is on dangerous ground if questions are asked of a female applicant that cannot be asked of a male one. If the higher income earner happens to be female and expecting a child, the adviser should not ask whether having the child would affect her ability to repay the loan – the same question cannot be asked of a male! Questions relating to the future earning potential of both partners are less sexist.

Self-employed persons, corporate applicants and partnerships each have to be considered in a different way.

The assessment of ‘salary’ for a sole trader is a little more difficult. A set of accounts will include a number of figures, eg gross profit, net profit and, possibly, personal drawings. The task for the adviser is to decide to what extent some or all of these figures should be taken into account in determining the applicant’s borrowing capacity. Before considering this issue it would be wise to explain the purpose of the various documentation that the applicant would normally be asked to provide in support of his application. A ‘set of accounts’ will normally comprise:

The profit and loss account is a record of the income and expenditure of the business for the trading year. It will show figures for gross profit and net profit for that year. Gross profit represents the gross income for the business less the cost of any raw materials necessary to carry out the main trade. For example, a painter and decorator will need a number of basic materials to enable him to work on a day-to-day basis. The cost of these materials will be deducted from his gross income to give the figure for gross profit. The net profit is arrived at by deducting routine business expenses from the gross profit. Business expenses include:

In looking at profit and loss accounts for a three-year period, it is important that the adviser identifies any unusual items or substantial differences between the account for one year and that for another year. For example, the profit and loss account for a particular year may show an expenditure item of, say, £1,000 for bank interest. If the account for the previous year did not include a figure for bank interest, then this indicates that a new bank loan had been arranged. If the accounts had been prepared by an accountant, then an explanation of this item may have been provided in the form of ‘notes to the accounts’. If no such notes were included, the matter may need to be investigated to establish the size of the loan, the repayment term and the monthly repayment.

While the profit and loss account covers the trading year, the balance sheet is a statement of the business’s assets and liabilities as at the end of the trading year, ie on one particular day. The balance sheet will include the balance of what is known as the capital account. This gives some indication of the underlying strength of the business as it comprises what remains of:

The capital account will also include a figure for personal drawings, ie the amount withdrawn from the business during the trading year.

In addition to the capital account, the balance sheet details other liabilities such as creditors and outstanding bank loans. The assets of the business will also be shown, eg the business premises, vehicles, equipment, debtors and the bank balance.

The profit and loss account and balance sheet show how well, or badly, the business performed in the past. But what about the future? The mortgage adviser will need some assurance that the business will continue to be viable, and that the applicant will be able to maintain the monthly payments, if a loan is agreed. It is impossible to predict exactly how well the business will perform in the years ahead, but if the applicant can provide at least one of the following items then the adviser may be sufficiently satisfied to enable the loan request to be approved:

Having examined all this information, the adviser must now decide whether to lend and, if so, how much. Almost without exception, lenders will regard the net profit figure as being the equivalent of gross salary for an employed applicant. It is therefore this figure to which the appropriate income multiple will be applied. However, it may not be quite that simple. The figure for personal drawings is also of vital importance. If this is more than the net profit, then the applicant could well be living beyond his means by taking more out of the business than it is making by way of net profit. Comparative figures covering, say, a period of three years, are of considerable importance. If personal drawings have only marginally exceeded net profit in one of those years then there may be a perfectly satisfactory explanation. However, if personal drawings have regularly been much higher than net profit then the adviser will need to proceed with caution. If the applicant is running down the capital account he will probably have to borrow elsewhere once the balance reaches zero. So, although the net profit for each of the past three years may look reasonable, the figures would be misleading and the application could well be declined.

There is one other matter on which the adviser needs to be fully satisfied, and that concerns the genuineness of the accounts. It is possible that the figures for net profit have been inflated to make the loan request look reasonable. How can the validity of these figures be assessed? The adviser can request the following documentation:

If the adviser is assessing business accounts covering a period of three years then the taxation documentation described above would need to cover a similar period.

A lender takes references, if appropriate, from the applicant’s:

None of these sources is totally foolproof. Probably the safest reference is that from the employer, where the company is an established and respected one. An employer’s reference should be:

As it is now easy to produce a reasonably high quality false reference on even a very basic personal computer, lenders have to exercise special care, following up to establish authenticity where appropriate. In addition, those who employ labour on a casual basis can sometimes be encouraged to produce a reference that implies greater permanence of employment.

How can a false reference be produced? Methods used in the past include:

• drafting one’s own reference on the company letterhead;

• forging the reference where the employer does not have formal letter-headed paper;

• colluding with the employer;

• colluding with a member of staff of the personnel department;

• re-dating an old reference etc.

The lender must be constantly aware of the danger of fraudulent references. Not only can this lead to committing funds that may not be repaid; failure to make appropriate checks can also invalidate future cover under the mortgage indemnity guarantee.

Lender’s references are also useful, though most institutions make a charge of at least £50 for these, so it is more common to rely on mortgage statements nowadays. A lender will almost invariably be truthful, especially as it can owe a duty of care to the recipient. The amount of information given will be constrained by the fact that the applicant has access to it under the Data Protection Act 1998.

A landlord’s reference may or may not be useful. In extreme cases, a landlord may be delighted to give a glowing reference to a troublesome tenant in the hope of obtaining vacant possession!

Most lenders are prepared to consider bank statements (and statements from other financial institutions) in order to assist in corroborating income and personal wealth.

Bank statements are only useful if they provide a representative picture of the customer’s well-being or otherwise and the fundamental nature of the person’s financial circumstances. The statements should indicate how the applicant has conducted his account over a given period of time.

One or two sheets of transactions are not particularly useful. The applicant may be going through a good or bad ‘patch’ that could be totally misleading. Statements should therefore be requested to give an idea of transactions over a certain minimum period of time. This should be specified in your own institution’s lending policy, so it is worth checking this out if you do not already know it.

Statements can be especially useful, as they provide a ‘pen picture’ of the applicant’s lifestyle. It is hard to disguise financial difficulties when it is known that the applicant has a main account with a particular institution.

Many applicants retain bank statements, though some do not. In the latter case, it can be expensive to obtain duplicates, as financial institutions commonly make charges for these.

Bank statements may appear to give a favourable impression of the applicant, but has the applicant got bank accounts with other institutions that are being deliberately concealed from you?

This has been considered in some detail above. We can summarise the information which may be required as follows.

Assessing the repayment ability of a partnership is not dissimilar to that for self-employed individuals: remember, a partnership – unlike a corporate applicant – is not a separate legal entity:

The assessment of commercial and semi-commercial applications should take account of both quantitative and qualitative information:

If the business uses solicitors and accountants who are known to have a bad reputation, this may send a warning signal to the lending institution, even though it may not in itself rule out the possibility of lending.

It is often necessary to credit assess company directors when a mortgage to a limited company is considered. This is because the limited company is a separate legal entity. Therefore, when a loan is made to a company, the institution is lending to the company itself, and not to either the directors or the shareholders (those who own it). Consequently, the lender may seek the personal guarantees of the directors by way of security to reinforce his position.

If guarantees are sought from directors, it may also be necessary to obtain the consent of their spouses if a main residence is offered as tangible security in support of their guarantees.

The company ran into trouble and went into liquidation. Although Mr Salomon was the main person behind the business and might appear to have acted somewhat unethically, the courts held that he was entitled to recover the secured loan of £10,000 before other creditors’ claims could be satisfied: the courts therefore recognised the clear distinction between the corporate entity and the individual shareholder.

All applicants for mortgage must provide full details of outgoings to the lender. For a typical household these might include:

It is relatively easy to identify most of these costs and to corroborate them from bank statements. If in doubt, the lender can always seek additional information.

It is here that an applicant is most easily able to deceive the lender. By omitting just one regular monthly payment, a completely false picture of the ability to repay the proposed loan can be given. Similarly, the extent to which the applicant meets his financial obligations each month can critically affect future payment capability.

Take credit cards as an example. An individual may have a credit limit of £1,000 on a MasterCard and another £1,000 on a VISA card. The minimum outgoing is £100 per month, assuming a 5% minimum payment. If the person then goes over the limit by £200 on each, the monthly payment is £100 (representing 5% of credit limit) plus 2 x £200, ie total £500. If the individual also has a charge card, the balance has to be funded in full every month. It is not unusual for a family to have at least two credit cards and a charge card, so the extent to which the obligations arising from them are serviced is absolutely crucial. Of course, bad payers will be identified by credit searches, but those with an otherwise ‘clean’ record are not necessarily certain to stay that way.

Where lenders are using an income multiple as their basis for assessing whether a customer can afford the loan, it is normal for repayments on other borrowing commitments to be taken into account so as to reduce the amount that the customer can now borrow. For example, the maximum loan available might be reduced by the balance outstanding on other loans or, alternatively, the monthly payments on these other loans might be deducted from the applicant’s income.

For example, John’s income is £35,000 and the lender’s normal income multiple is 3.25. John has a £12,000 car loan. In this case, the lender might reduce the advance by the outstanding loan – 35,000 x 3.25 – 12,000 = 101,750. Alternatively, John’s loan payments of £300 a month could be deducted from his income before the income multiplier is applied, say, £35,000 – £3,600 = £31,400 x 3.25 = £102,050.

One major threat to the future ability to repay a loan is if the applicant is awaiting an assessment by the Child Support Agency of how much should be paid to support his children. The lender can reduce but not eliminate such risks by asking appropriate questions when it is known that the applicant has children by a previous relationship and where a settlement is to be made.

When considering outgoings, the mortgage adviser may be able to make a valuable contribution to improving the financial circumstances of the applicant. For example, there may be existing borrowings at very high interest rates which it might, subject to status, be possible to consolidate in a new lending arrangement. In addition, some applicants may have household insurance policies for which they are paying ‘over the odds’.

For commercial and semi-commercial applicants, remember that past performance is by no means a guide to future prosperity or otherwise. Entrepreneurs rarely predict their own death, yet businesses fail nonetheless. The problem is compounded by the fact that formally prepared accounts are subject to distortions:

Future expenditure by corporate and semi-corporate applicants is subject to even greater potential fluctuation than personal borrowers. For example, a major capital investment may increase borrowings, and therefore monthly costs, substantially. Businesses subject to seasonal fluctuations in income and costs need particular attention when looking at their overall well-being or otherwise.

Seasonal fluctuation in income is common in a wide variety of businesses, including guest houses, many retail outlets and the wholesale trade.

A good guide to cash generation capability is net operating cash flow, measured by taking operating profit and adding or subtracting non-cash items as appropriate.

As we have seen, lenders can take references from a number of sources, including employers, lenders and landlords. Arguably, statements are more useful. These provide a good indication of track record and lifestyle.

Particular points to look for are:

Regular income may be more than just salary and wages. It can include maintenance payments, trust income and interest on investments.

References and statements will not tell the lending institution about:

These are an integral part of the credit assessment process. The starting point is to establish whether the person applying for the mortgage is permanently resident at the address given in the application form. This can be confirmed by checking the electoral roll. In the majority of cases there is no difficulty in establishing this. The ris not, however, totally up to date at all times. It tends to be amended once a year, using 1 October as a cut-off date. If a person has moved recently, the address will obviously be different, so it is necessary to cross-refer to the immediate previous address given in the application form. In a minority of cases, there will be no record on the electoral roll – for example, a family moving back to the UK after living and working abroad. Here the lender has simply to use whatever evidence can be obtained.

Credit reference searches can be made through organisations such as Experian (formerly CCN) and Equifax. These organisations, known as ‘credit bureaux’ or ‘credit reference agencies’, store and maintain financial and public records of people who have received credit. These organisations have vast databases of information on individuals in respect of previous bad debts and default, County/Sheriff Court judgments and insolvency.

Advisers should be aware that under the Data Protection Act 1998, data subjects have a right to access any information held by lenders, either on computer or in paper-based files.

Credit reference bureaux provide such information for a fee of £2.00. Credit references provide an insight into the activities of individuals based on historic information. They are a useful tool in bringing to light specific instances of problems with a named individual. This is in contrast with the statistical insight given by another tool, credit scoring, which we will look at next.

Practically all lending institutions use credit scoring as an integral feature of the assessment process. It is a method by which scores are apportioned to various features of the application, based on historical data relating to risk.

Other categories that might be taken into account, for example, could be whether the applicant is a first-time buyer or not, their age, their occupation, whether the application has come direct or been introduced, and the amount of the loan.

In simple terms, a certain number of points are then allocated in each category, (eg five points for a first-time buyer, ten points for a next time buyer) so that once the points for each category have been added up you end up with the total score. Applications that receive more than a certain score (often known as the ‘cut-off’ score) will be accepted, while those that do not would be declined.

Credit scoring techniques are now well developed and highly sophisticated. They are invariably computerised to enable the lender to apply them quickly and accurately. Furthermore, the scores can be changed to reflect the changing profile of the mortgage book. Critics of credit scoring suggest that it removes the ‘human element’ from lending. Although there is some truth in this, a good system is able to incorporate override features enabling discretion to be applied.

For example, many lending organisations’ systems will allow for scrutiny of ‘borderline’ applications – those that achieve a score at or around the lender’s agreed cut-off point. This means that such applications can be referred to a supervisor or loans officer for review – recognising that scoring systems may have their limits ‘at the margin’ and that some human intervention may be of help with these borderline cases. So, for example, the lender’s policy may grant discretion to supervisors to ‘override’ marginal fails which come within a certain number of points of the cut-off. For cases that are clearly well above or below the cut-off, intervention and review is unlikely to be necessary if the credit-scoring model has been well constructed.

Credit scoring models are not static: they have to change with the changing environment, and lenders keep them under constant review for their robustness – a model which worked well ten years ago would be unlikely to be as robust today. In addition, it is important to recognise that:

We have noted that there is no single credit-scoring model:

However, certain elements of credit scoring models remain constant. There are some factors about applicants that we could ascertain but which would be of limited assistance in predicting their likely future financial behaviour – eye colour and height, for example. There is clearly little merit in including such criteria. However, other factors can be shown to be more consistently useful: for example, such factors as employment status and length of employment, income, credit history, home ownership status and length of time in current residence. (A number of these questions will be familiar to you if you have helped mortgage applicants fill out standard application forms in the past). Organisations gain experience over time as to which items of information contribute usefully to the model and which do not.

On its own, each of the above factors presents a far from complete picture and even taken together they present only a statistical likelihood of default. However as a tool to help lenders screen out applicants where there is a high likelihood of default, and therefore manage their risk exposure, credit scoring has undoubted applications.

Credit scoring is especially useful when:

Credit scoring has proved its worth in the field of high volume unsecured lending operations, such as finance houses. Its speed and accuracy enable credit scoring to be employed as a means of processing many applications in a short time. As technology has improved, lenders have been able to develop sophisticated databases so that credit scoring can be used for mortgage applications and even quite complex corporate loan applications.

When a person is unable to pay his creditors, a civil case can be brought to the county court in England and Wales or the Sheriff Court in Scotland. The court can make a judgment (decree in Scotland) against the debtor that then remains in force until such time as the debt is paid.

The application form always requires details of such judgments and it is a criminal offence to knowingly conceal them from a prospective lender.

Although judgments do not rule out the ability to get a mortgage, they have to be considered within the context of the application as a whole. A person who has been unable or unprepared to meet obligations in the past may be regarded as less reliable in the future.

Some lenders are prepared to consider ‘high risk’ clients with a poor track record – several charge high rates of interest and impose onerous conditions for late payment.

In 1997, following pressure from the Office of Fair Trading, one lender specialising in such mortgage business introduced less onerous conditions in mortgage contracts for new customers.

Insolvency occurs when:

Insolvency arises when an order is made under the Insolvency Act 1986 or the Bankruptcy (Scotland) Act 1985. Under the Enterprise Act of 2002, once made, a bankruptcy order remains in force for 12 months in most circumstances. The bankrupt is made responsible to an insolvency practitioner whose primary duty is to ensure that the creditors get as much money back as possible during the period that the order is in force.

A bankrupt cannot borrow (except very nominal amounts) in his own right.

Bankruptcy will normally be declared on the mortgage application form – it is a criminal offence not to do so. If undeclared, it will usually be revealed by credit searches, and the bankrupt is legally prevented from executing a mortgage deed.

As a matter of routine, lenders often decline applications from undischarged bankrupts. Some lenders are prepared to consider applications from those who have been discharged from bankruptcy after a specified number of years.

An IVA is an alternative to bankruptcy. It is a method whereby a debtor can make an arrangement with creditors to reschedule outstanding debts over a specified period, supervised by an insolvency practitioner. For an IVA to be arranged, a creditors’ meeting must be arranged. At the meeting, creditors representing at least 75% of the debt must agree to the IVA. For example, if the debt is £100,000, creditors owed at least £75,000 in total must agree to the IVA.

Obviously, those subject to IVAs are considered by all lenders to be a poor credit risk, though in a minority of instances a mortgage may be a solution to the overall problem.

These are the limited company equivalent of IVAs.

It is clearly not possible to interview every single customer, but when it is possible to meet the applicant the interview can be a valuable exercise for both customer and adviser:

The mortgage adviser has to balance the need to be thorough with the time pressures that invariably affect applicants. It is therefore essential to have a proper interview structure and sound technique to obtain concise and unambiguous answers within a reasonable time frame.

Information on the applicant should be collected in order that known information does not take up unnecessary time, except to confirm those matters that are necessary. The applicant may be an existing customer, in which case there will be details of savings or mortgage accounts or both, as well as other products bought during the period in which the customer has transacted business with the institution. This should give vital clues not only to needs but also to lifestyle.

Every customer is different, so it is impossible to follow an entirely structured approach. The talkative customer will want to drive the interview and will present problems if the meeting goes off at tangents. The quieter customer may prove to be just as difficult if the adviser cannot get him to ‘open up’ on product requirements.

Nevertheless, all interviews should have the following.

The customer is made to feel welcome and rapport established.

This should focus on customer needs. Some advisers use a ‘factfind’ approach, asking open questions to get the customer to talk about needs, followed by closed questions to tie down potential product options or other courses of action.

Many customers shop around for the best mortgage deal and will be reluctant to sign up for anything. Some will be well briefed on competitors’ products – here the adviser has to be able to meet resistances and objections with statements of value about his own institution’s products. One major factor that determines the credibility of the adviser is knowledge of products and the market in general.

During the interview it is important to ensure that explanations, both of the general principles under discussion and of any specific products referred to, are complete and clear enough for the customer to understand them. Care should be taken to give information on products/services in plain language, and to offer to help customers to understand any aspects of them. Customers should also be helped to choose a mortgage appropriate to their needs, if such help is required to understand the financial implications of having a mortgage; and to help them understand how their account will work in practice.

Here positive courses of action are decided and confirmed. This need not necessarily be a ‘closed sale’, as many customers will have to go away and think about what to do next. Some may need to provide more information before a decision can be taken on the prospective purchase. The important thing is to have an outcome that is in the control of the adviser so that follow-up action is possible.

Both the customer and the adviser should leave the interview knowing what comes next. This might be:

Those actions that are in the hands of the institution should be followed up swiftly and in accordance with what has been agreed. If the customer goes away to think about the proposition, the business may be lost to a competitor, so as far as possible the adviser should suggest that a telephone call or letter will follow at some agreed time after the interview. This might not be possible in every single situation, but it will greatly reduce the possibility of losing the business altogether.

Despite thousands of pounds being spent on customer care by financial institutions each year, research through ‘mystery shopper’ surveys has established that follow-up activities can be poorly handled and in some cases are non-existent.

Fraud occurs when a person deliberately sets out to obtain funds from another person or organisation by dishonest means. In recent years, the incidence of mortgage fraud has increased significantly.

In the early 1990s, a police federation report estimated that as many as one in twenty mortgage applications could have included some element of fraud. The extent of the crime could vary from a simple over-statement of income to highly organised and systematic professional fraud attempts.

Types of fraud in relation to mortgages:

Advisers also have to be aware of fraud that can arise in respect of:

Fraud costs the financial sector millions of pounds each year. It is therefore a major area of focus to individual lenders and trade bodies such as the Council of Mortgage Lenders (CML).

Measures that can be taken to combat fraud include:

The Theft Act 1968 enables a lender to initiate a prosecution where an attempt is made to obtain a mortgage by deception, whether or not the mortgage is actually granted.

During the application process, as we have noted, references will be taken on the applicant (where he is an individual), on the partners in the case of a partnership, and on the directors where the applicant is a company.

The Data Protection Act exists to protect the rights of individuals where information is held about them: the term ‘data’ includes both facts and expressions of opinion about people – and so the statement ‘we consider this individual to be creditworthy’ in response to a credit reference request would be covered under the Act. The Act requires that information so held should be:

The quality of a reference can clearly have a big impact on an individual’s life in terms of their ability to obtain credit. The Data Protection Act clearly covers the treatment of such references, and it (and the Consumer Credit Act 1974) gives people the right to see the information held on their files with Credit Reference Agencies – for a nominal fee of £2.

The Criminal Justice Act 1993 introduced new provisions aimed at preventing the use and abuse of the financial system to conceal the proceeds of their crimes and, ultimately, to give those proceeds the appearance of being legitimate. Among other things, these require that:

The enactment of the Financial Services and Markets Act 2000 brought responsibility for fighting financial crime into the remit of the Financial Services Authority. Prior to this, prosecutions under the Money Laundering Regulations 1993 (issued under the Criminal Justice Act 1993) could only be brought by the UK criminal authorities. Therefore the FSA now has a more direct remit in connection with the enforcement of anti-money laundering provisions.

On the face of it, the taking-out of a mortgage may not be the most obvious route which a money-launderer would take: after all, lenders are likely to go to some lengths in terms of identifying applicants for credit. Furthermore, money raised by way of mortgage might be expected to remain tied up for some considerable length of time whereas there is a common (although not always correct) perception that accounts used for laundering purposes are highly transactional in nature and have a large volume of turnover.

In any event, the anti-money laundering provisions apply to financial institutions undertaking mortgage business just as much as they do to anyone else, and so organisations will at the outset take specific steps to ensure they have obtained evidence of a client’s identity; they will also require evidence as to the source of any funds deposited with them, which might include, for example, the deposit moneys on a property being bought.

On an ongoing basis, the lender should also ensure that its staff are alert to any use of the account which does not fit the expected pattern, and that they report this to the lender’s designated Money Laundering Reporting Officer.

That is not to say that every unusual or unexpected transaction is evidence of crime; there may be some perfectly innocent explanation arising out of the customer’s changing circumstances. However, it is important that staff remain alert to the possibilities, and take appropriate action whenever their concerns are raised. The current Money Laundering provisions are certain within the Proceeds of Crime Act 2002.

As well as more generalist providers, the mortgage market is home to a number of specialist businesses that have made a niche in lending, or arranging loans, to or for people who might not fit neatly into standard lending criteria.

Among others, these include organisations that have expertise in lending to those with impaired credit track records (for example, they have county court judgments against them), or to those who are self-employed and have such short track records that they cannot supply a number of years’ past accounts. Such people might fail the lending criteria of a generalist lender because they do not fit into the lender’s model of the ‘norm’. However, this does not necessarily mean that they do not represent good business propositions – it just means that they require different and more specialised assessments.

Of course, such borrowers may often also represent a higher degree of risk. Part of the skill of the specialist lender or packager lies in setting the right level of interest rate to compensate the lender for this additional risk. This is often called setting the ‘rate for risk’.

Where the prospective borrower is in fact a worse risk than more standard cases – as opposed to being, for example, simply out of the normal run of things – he may be described as ‘sub-prime’ (ie of less than perfect credit quality). Lenders who specialise in this market are themselves therefore sometimes referred to as sub-prime lenders.

The mortgages offered by sub-prime lenders reflect the risk taken, and are usually slightly higher than those applying to conventional mortgages. The borrower will also have a more limited range of options to choose from.

The steady increase in house prices in recent years has prompted many people to release the equity in their homes and indulge in spending on luxuries such as cars and holidays. There is considerable evidence to suggest that some people remortgaged their property to a lender who was willing to accept self-certification of income. This certainly led to some applicants being less than truthful about their income as with low interest rates they felt that they would have no difficulty in meeting the monthly payments on a large loan. In some cases it has been suggested that mortgage intermediaries actually encouraged applicants to inflate their income on the basis that the lender would not seek verification.

Some self-certification lenders have now withdrawn from the market, whilst most of those that remain have introduced more stringent underwriting criteria. Although these lenders do not attempt to verify income, they still act prudently by subjecting each applicant to an internal credit scoring process as well as making the standard credit searches. It is quite possible that those who deliberately inflate their income have an adverse credit rating, although this will not always be the case. As far as income is concerned, experienced underwriters will know instinctively what is a reasonable income for a particular occupation and as more and more self-certified applications are processed the easier it will be to identify the fraudulent ones. Applicants should remember that exaggerating income in order to obtain a higher loan amounts to fraud, irrespective of whether a loan is actually granted. In this respect, a lender that specialises in self-certified loans is no different from any mainstream lender and would be entitled to prosecute an applicant who it was felt had deliberately set out to deceive. A mortgage adviser who encourages such deception would no longer be deemed to be a fit and proper person to give mortgage advice by the Financial Services Authority.

Section 3

Assessment of security

Before entering into any mortgage contract, the lender will ensure that a valuation is carried out to assess the adequacy of the security for lending purposes. This is a matter of prudent lending for all institutions, but in addition is a legal obligation for building societies.

There are essentially three types of service available for mortgage applicants.

The basic valuation is carried out on behalf of the lending institution to assess the adequacy of security for mortgage purposes. The valuer may be a professional outside (panel) valuer or an employee of the lending institution. The task is carried out on behalf of the lender, not the applicant, although the applicant pays the fee if charged. The contract is therefore between the lender and the valuer.

It is vital that the mortgage adviser stresses to the applicant the shortcomings of a basic valuation. If the mortgage is granted, the borrower will be paying out thousands of pounds over several years. It is, therefore, in his own interest to get value for money from this major purchase.

Advisers should emphasise the limitations of this valuation. The basic valuation often lasts as little as half an hour and is, by definition, a fairly superficial inspection – only obvious visible defects will be reported. The valuer completes a report to the lender, recommending whether or not the property is acceptable as security for the advance requested, the value of the property for lending purposes and the insurance value. It is important to note that the valuation for lending purposes is not necessarily the same as the market value of the property. The report will also highlight any essential repairs.

Typical defects identified in a valuation report would be:

Based on the valuer’s recommendations, the lender will decide whether to lend and, if it chooses to do so, how much. It will also decide whether to insist that the applicant undertakes to carry out specified repairs within a given period, or even to hold back some of the advance moneys pending such repairs.

All lenders disclaim any responsibility for the condition of the property, and will specifically state that they do not give any warranty as to the reasonableness of the purchase price.

In isolated cases, borrowers have brought actions against valuers, claiming that a duty of care is owed in negligence. These cases are less likely to succeed in future, now that lenders give specific advice on the limitations of the basic valuation. Where such cases do succeed, it is usually on one of two grounds:

It is worth noting that Mr Stevenson, in bringing this case, sought to rely on the fact that the disclaimer used in the valuation was ‘unreasonable’ under the Unfair Contracts Terms Act 1977. This legislation – now updated by the Unfair Terms in Consumer Contracts Regulations 1999 – aims to protect consumers from terms which are unfair and to the detriment of the consumer, where the terms have not been individually negotiated. While Mr Stevenson failed in his particular case, the legislation could arguably be relied on in certain circumstances.

The question of whether a lender is better to use in-house or external valuers is a matter for the lender’s policy: however, it is worth bearing in mind the above point. While in-house valuers have the advantages that:

The use of external valuers has the counterbalancing advantages that:

In any event, it is clear that the valuation is a very important document to lenders and borrowers alike. Borrowers have to be made fully aware that it is in their interests to look closely at the condition and value of the property they are considering buying, before going ahead. Buying a house may, after all, be one of the most expensive purchases they ever make.

This is a ‘half-way house’ between the basic valuation and a full building survey. It is easy to condemn someone for not commissioning a full survey, but the price is prohibitive to many, especially when one accepts that moving house is an exceedingly expensive time. Because of this, lenders offer the homebuyer’s report as a moderately priced option, well within the budget of most prospective mortgagors. The commissioning of a homebuyer’s report establishes a contract between the applicant and the surveyor.

The report identifies any problems that are relatively obvious: that is, the valuer will walk around the property so as to identify any problems that are visible to him. He will not however lift carpets, shift heavy furniture about and the like so as to discover what problems may be hidden by them.

Again, the report is limited in focus, and will inspect those things that can be seen fairly easily. For example it will not involve lifting carpets to inspect floors. There is little comeback in the event that serious problems are encountered later. The applicant does, however, have a good chance that defects will be identified, giving an opportunity to turn down the property, make an amended offer or plan expenditure necessary to redress the problems. Typical defects identified in the homebuyer’s report would be:

A full building survey is a thorough and complete inspection of the property carried out by a qualified professional surveyor, engineer or architect. It is expensive but, nevertheless, worthwhile for many mortgage applicants. If the property is defective, this will almost certainly be discovered by a full survey. If it is not discovered, the borrower has some comeback against the surveyor, whose duty of care is to the applicant only.

Such a survey will be more detailed than the homebuyer’s report, comprising an inspection of the state of the electrical system, drains, damp-proofing and damp-coursing. It should be thorough enough to identify any major, and indeed more minor, problems. It should be carried out to certain standards, and so in the event of later problems the valuer may be liable for any losses as a result of his negligence.

In some instances, the lender will not accept a full building survey that has been commissioned by the buyer and will still insist on a valuation for its own use. This may happen, for example, if the surveyor is unknown to the lender or if it would necessitate considerable time or expense to validate the surveyor’s credentials. This has been the subject of a Monopolies and Mergers Commission report in 1994.

To reinforce your study of this area, you should obtain a lender’s literature on survey and valuation services and read it thoroughly. It is also useful for you to know your way around the valuation report form used by your in-house valuers.

It is not possible to give exact costs for each type of survey, but typical costs for a £250,000 property would be:

Valuation – £250 – £300

Homebuyer’s report – £450 – £550

Full building survey – £600 or more, depending on the size, structure and age of the property.

In the event that a valuation or survey identifies a potential concern, further specialist reports may be required.

It is important to bear in mind that there is no refund on a survey or valuation if the sale does not go through.

As we saw in Unit 3, the government has proposed and piloted the concept of ‘Home Information Packs’, chiefly with the aim of speeding up the house-buying process. These packs would include necessary details on the condition of the property and would obviate the need for each prospective buyer to arrange his or her own survey. As we have noted, the principle of packs prepared on behalf of the seller (as opposed to the buyer or the lender), and the practical issues arising out of the pilot, are the subject of some debate in the industry. You should ensure that you remain up-to-date on developments as to their ultimate introduction.

The contents of the Home Information Pack are intended to include: evidence of the ownership of the property and the results of all necessary searches, and a home condition report (which is not dissimilar to the homebuyer’s report described above, but which includes elements of a full structural survey and an energy efficiency rating).

The Scottish Executive has recently confirmed that, following a series of trials, legislation will be introduced in Scotland requiring the seller to make available a ‘single survey’ to all potential buyers. The rationale for this is that most buyers in Scotland relay on a ‘valuation only’ survey because of the costs associated with multiple surveys and often subsequently discover that they face substantial repair costs.

Advisers should not recommend a specific type of survey, eg a homebuyer’s report or a basic survey. For example, if the adviser specifically recommends a home buyer’s report and something later comes to light that would have been picked up by a full survey, the adviser may be subject to a claim. However, if the surveyor misses something that should have been covered by the home buyer’s report, the adviser will not be liable.

These rather ugly terms represent ugly practices!

Gazumping is the situation where, having formally accepted an offer on a property, the vendor accepts a better offer. Under current legislation this is not illegal and happens often in a buoyant market. Many people blame estate agents for gazumping, feeling that, once an offer has been made they should not entertain others. The problem is that estate agents are obliged to obtain the best price for the vendor and to pass on all offers made. One solution would be to take the property off the market once an offer has been accepted. However, an offer is not binding until contracts have been exchanged. This means that the buyer could drop out at any stage before exchange of contracts with no penalty – the sale is not guaranteed. If this happens, the vendor will have lost valuable time and the property will have to be remarketed; better to keep it on the market just in case.

Gazundering is the situation where, having had an offer accepted, the potential buyer finds a reason for reducing the offer. In some cases this is entirely reasonable – the survey might have identified problems, or other factors might have come to light. In many cases it is pure brinkmanship – the buyer makes a last minute reduction in the offer, gambling on the fact that the sale has almost gone to exchange of contracts and the vendor will not want to start again. As with gazumping, this practice is not illegal.

In Scotland, an offer to buy is legally binding and a contract for the sale of a property can, in principle, be concluded very quickly. In practice, the conclusion of missives (ie the acceptance by the seller of all the terms of the buyer’s offer) takes some time and in the interval either party could withdraw from the bargain. Therefore, both ‘gazumping’ and ‘gazundering’ can, in principle, occur in Scotland. However, the practice of setting a closing date for the submission of all offers, and the tendency to favour unconditional offers over conditional, has generally meant that the problem is not widespread in Scotland.

The vendor must have title to the property in order to sell. If it is in dispute, the property may be worth less – it may even be unsaleable.

Land in England and Wales is either freehold, leasehold or commonhold. There can, however, be many factors that can create defects in title that have a knock-on effect on market values.

Most lenders insist that leasehold property have a specified minimum period unexpired on the lease beyond the end of the mortgage term. In addition, problems can arise in respect of ‘common areas’ of freehold flats (ie one person’s ceiling is another person’s floor). As a consequence, many lenders will not consider freehold flats for mortgage.

In some parts of Scotland, property has to be ‘de-crofted’ before a title can be created for a new purchaser. This often occurs when a farmer sells off a portion of agricultural land so that a purchaser can build a dwelling on it. This action can be time-consuming and quite technical.

As mentioned briefly above, some land has rights attached for the benefit of others. In England and Wales these are usually easements (such as rights of way, rights of light and the right to hang a sign on someone else’s building).

In Scots law the technical term for these is jura in re aliena (rights in a thing belonging to another, or servitudes). For example, a creditor might have some right over his debtor’s property pending settlement.

These matters can affect value. If not apparent to a valuer, they will be discovered by the solicitor acting.

Geographical location is of great importance when considering the value of a dwelling. Generally, areas of economic prosperity attract population clusters that drive up demand. This is not to say that sparsely populated areas will have lower property prices: sometimes this results in higher prices to reflect exclusivity.

Even within certain towns and cities, the very name of a district can add value to a property. Think of your own area and you will easily come up with names of districts that are considered ‘up-market’ and those which are deteriorating.

Quite obviously, the type of property will have an impact on its value. Generally flats are less valuable than houses, and detached houses are more valuable than terrace and semi-detached houses. Bungalows are often more expensive than a house with a similar number of bedrooms, although bungalows do appeal to a more limited market. This could mean they are less sought after in areas where there are many bungalows.

The design of a dwelling is very much a matter of personal taste. What is delightful to one person is hideous to another. Obviously, lenders like to see mortgage customers obtain the type of dwelling they prefer.

Sometimes, a property can be so unusual that the lender will seriously doubt its resaleability. This is a factor that all lenders have to heed. As well as looking at market value, the lender must consider value in a ‘forced sale’ situation; this is where the lender has to take possession due to default on the loan. If there is a limited market for the property, or even no possibility of a buyer, the land is almost worthless in the short term.

The age of the property will be another factor in determining the value. Period property with original fixtures and fittings can often be at a premium over its modern counterparts, providing, of course, that it is in sound condition. The amount of similar property in an area will be a contributory factor – where there is a glut of older property the premium may be reduced; where period property is rare it could increase. Ultimately, the price achieved for a property, new or old, will depend on its appeal to the buyer, its condition and potential.

Bricks, blocks and tiles are orthodox media for constructing properties. Over the years, there have been many innovations, some of which have enhanced quality and some of which have reduced it. Property of standard construction is highly mortgageable – non-standard buildings could be difficult to mortgage, as a result of which the value could be reduced.

Regardless of the property’s age, surveyors will distinguish between traditional and non-traditional construction. Traditional construction is, generally speaking, bricks, mortar and tiled roof. Non-traditional construction could involve pre-cast concrete panels attached to a steel or timber frame. For non-traditional construction, there may be inherent faults that reduce the potential lifetime of the property. For example, many new builds are constructed using non-traditional methods. For new builds, lenders consider whether the builder participates in the ‘Buildmark’ scheme. For non-traditional construction completed prior to the launch of these schemes, lenders may not be willing to lend. For example, many council houses were built after the 1939-45 war using pre-formed concrete panels slotted between steel rods. They were only intended to last 20 or 30 years. Many of these houses are still standing but the rods have corroded; expensive repairs or rebuilding will be required. As a result, lenders will not consider them for mortgages.

It is important to note that buildings constructed in the traditional way may also be subject to property defects. Property defects affecting the value of the property and/or the decision to lend are considered below at 3.1.3.14.

There are many factors which impact on the value of the property and the costs of maintaining it. A house with a large proportion covered by a flat, felt-covered roof, for example, may need the felt replacing regularly. The insurance company may also impose a higher premium for buildings cover.

The materials used in construction can crucially affect the value and expected life of the dwelling. The latter point is very important to a lender with a 25-year loan secured on the property.

For new properties, lenders prefer that the builder is a member of the National House Building Council (NHBC). This organisation introduced a scheme in 1965 that provided a guarantee against major defects.

The mortgage adviser should never encourage an applicant to assume that just because a property is new or nearly new it will be in good condition.

The scheme was relaunched in 1988 as ‘Buildmark’. It serves as both a protection scheme and as a warranty. To join the NHBC, builders have to satisfy certain quality standards and as part of the Buildmark scheme, builders have to confirm that the property has been built to NHBC standards. In addition, NHBC personnel conduct site inspections to monitor standards.

The Buildmark scheme provides protection against all defects and damage during the first two years, where it is caused by the builder’s failure to meet NHBC standards. For the balance of the first ten years it provides insurance for the full cost of damage over £500 caused by defects in the building’s structure. It details how a purchaser must make a claim, if the need arises. The claim is made to the builder initially, but it will go to the NHBC in the event of a dispute.

A similar scheme was started by the Municipal Mutual Insurance Company Ltd, and has now been replaced by a scheme with the Zurich Mutual Insurance Company. The main difference is that the scheme covers a 15-year period.

If the builder is not a member of NHBC or a similar scheme, the lender usually insists on a qualified supervising architect regularly inspecting the property under construction.

Second-hand properties which are more than ten years old have to taken on merit and valuer’s recommendation or otherwise. Some lenders insist on a detailed survey for properties over a certain age (for example, 50 years).

That condition affects value is obvious. A prospective purchaser might be willing to invest additional capital in a property to ‘bring it up to scratch’. This can be an opportunity to lend more if the eventual value is likely to be much enhanced by the work to be done.

One factor to consider is whether similar properties in the locality are in better condition. If so, are there any on the market and what are their prices?

Valuers will take special note of necessary repairs and report these back, with recommendations, to the lender.

A property with dry rot that has remained untreated for some time can pose serious problems to the owner or a potential purchaser. Dry rot spreads rapidly, as it is carried by spores that quickly affect other areas. Consider a property with ten internal doors and frames, all affected by dry rot. The minimum one could expect to pay to remedy this, is about £150 per door – total outlay £1,500, and that is without considering any window frames or other woodwork which might be affected.

Some property is designed for more than one use. A building containing a shop and a flat above, for example. The multiple use aspect could have a detrimental effect on the flat and some lenders may decline to lend.

Although quite rare, some properties are sold with a ‘sitting tenant’, someone who has a tenancy agreement with the current owner and is protected by law. A sitting tenant will devalue a property. Most buyers will want ‘vacant possession’, which means that they will have unrestricted use of the property and no sitting tenants. Few mortgage lenders will lend on properties without vacant possession.

Insurability could affect the valuation of a property. Is it insurable? Some properties are uninsurable, or at best difficult to insure. This is the case with properties on flood plains and near rivers where flooding is commonplace, and properties on or near cliffs where erosion is evident. In many cases it will be difficult to obtain a mortgage on these properties. Is there a history of subsidence – insurance companies are reluctant to cover property in areas where subsidence has occurred, or properties with a history of subsidence that has not been professionally rectified with guarantees. Again, the property value will be reduced in this situation and lenders may be reluctant to lend on this type of property.

Planning and building regulations are dealt with in detail later in this manual. When a property owner extends or undertakes other building work on the property, he may be required to seek planning permission or follow specific building regulations. Failure to do so could result in a compulsory order to reinstate the property to its original state. In terms of property values, failure to obtain the necessary consents will seriously devalue the property and is likely to result in lenders choosing not to lend on the property.

Increasingly, the environment in which a property is located has a major effect on its desirability and therefore value. For example, there have been two comparatively recent developments that have had a serious effect on owners of certain houses. Neither would have bothered would-be purchasers even a few years ago:

Road widening schemes are both common and controversial. In the early 1990s, some householders in Luton had a portion of their gardens compulsorily purchased in order that the M1 motorway could be widened. The compensation offered was at then-current values that were, of course, lower than had been the case only two years earlier due to the property slump. Lending institutions therefore have to be aware of such developments and their likely effects on neighbourhoods.

In addition to the above, surveyors will take into account the geology of the land. For example, homes built on ‘London clay’ can be prone to slippage and subsidence.

Other environmental factors include proximity to flood plains, busy roads, mobile phone masts, substations, etc. These factors are unlikely to affect the lending decision, however they may affect the future marketability of the property and therefore the value of the lender’s security.

Agricultural properties bring with them some special areas for care. Not only is farming a far from trouble-free industry: there is in addition some specific legislation that may mean that expert advice should be taken. In particular, the Agricultural Holdings Act 1948 gave tenants of agricultural land a high degree of security of tenure (ie they could be very hard, if not impossible, to evict). Further, where there was evidence of poor land management, the Act allowed land to be taken out of the owner’s control under a supervision order. Subsequent legislation by way of the Agricultural Holdings Act 1986 and the Agricultural Holdings (Amendment) Act 1990 updated the situation somewhat, but loans against the security of farmland and the like should still be approached with care and advice taken where necessary.

As a consequence of the difficulties and uncertainty the legislation presents to lenders, in terms of their ability to exercise their security promptly and effectively, some do not lend against land classed as ‘agricultural land’ at all. Further, the question of what is or is not classified as ‘agricultural land’ for the purposes of the Act can turn on fairly fine areas of detail as to how it is used. Thus applicants for a mortgage in this area may need to seek out lenders with expertise who are comfortable lending on such security; however, as noted above, the recent changes may in some areas have made applications somewhat easier.

In surveying a property, surveyors may come across certain defects which affect the value of the property and which may affect the mortgage lender’s decision to lend. The most important of these is structural movement. Structural movement can be related to walls, floors or the whole building. The surveyor will consider whether this movement is long-standing and non-progressive or recent and progressive. Long-standing and non-progressive movement will not normally affect the decision to lend or whether to attach undertakings to the mortgage. However, if the movement is recent and progressive the surveyor will normally recommend that a structural engineer take a look at the building and that further investigations are carried out. Lenders may attach undertakings to the mortgage terms that require the prospective purchaser to carry out remedial works within a specified period of time. If the further investigations show that the movement cannot be remedied, the lender may decide to refuse the mortgage.

Further defects which may affect the decision to lend, or which may prompt the lender to require remedial undertakings of the borrower include untreated woodworm, severe damp, removal of chimney breasts, extensions which do not conform to building regulations and the replacement of traditional roof coverings with concrete. This list is not exclusive and may vary from lender-to-lender.

The valuation report forms the basis of the lending decision, and will influence with regard to the following:

Most basic valuations are reported on the lender’s standard form for this purpose. The questions will be relatively few in number and mostly non-technical, although, invariably, lenders leave space for the valuer to make detailed comment.

The list below represents one lender’s approach. A better source is your own organisation’s valuation report form. You should compare this with the list below:

Subsidence occurs when land below the property drops unevenly, causing the property to shift. Heave occurs when underground forces cause the land below the property to rise unevenly. Both are usually serious problems with major expenditure an inevitable consequence.

In the UK, these problems can be quite localised and professional surveyors and valuers tend to know areas at risk. For example, some buildings close to the Thames basin have been affected in the past due to shrinkable clays in the ground. Further afield in Ireland, some areas around Cork on the south coast are similarly affected – hardly surprising perhaps, as the name ‘Cork’ is derived from the Gaelic ‘corcaigh’ meaning ‘swamp or marsh’!

The disclaimer which is invariably included by all lenders in respect of the condition of the property has to be prominent to be effective. In the famous Yianni case, which was ruled upon by the House of Lords in 1981, the judge ruled that the disclaimer had to be sufficiently prominent to reflect its importance. Some lenders insist that the applicants sign or initial that they have read and understand the disclaimer.

The valuer can recommend a number of alternative actions:

If the valuer recommends a retention, the mortgage adviser should make it clear to the applicant as early as possible that extra funds will have to be found to enable the purchase to be completed.

If the valuer considers that the property is worth less than expected by the vendor and/or the purchaser, there can be significant consequences. This may result in a smaller mortgage being offered by the lender. There are several possible outcomes:

If a valuer is in doubt about any features of the property, he will recommend a further, more detailed report, prior to final consideration for mortgage. In particular, any evidence of subsidence or heave (where the ground is unsound beneath the property) will be investigated fully. A large number of insurance claims for such defects actually result in abandoning the property to the insurer. It is, therefore, important to identify these problems before the lender enters into any commitment.

Fortunately, problems of subsidence or heave are often localised or predictable. They are caused either by the underlying nature of the land beneath a dwelling or previous use of the land (eg mining beneath the land or use as a landfill site).

Valuers sometimes recommend the involvement of specialists such as structural engineers, drainage experts or arboriculturists (tree experts).

It can be beneficial for a prospective purchaser to have a full building survey at valuation stage, so that the additional cost of the basic valuation is eliminated. The adviser should take great care early on in the application process to recommend that anyone contemplating this should check first to ensure that the surveyor used is acceptable to the lending institution – otherwise, the valuation fee will be incurred anyway.

This was subject to comment by the Competition Commission in a report in 1994. Members of the Council of Mortgage Lenders now undertake, through a Statement of Practice, to advise the applicant of this as early as they can to avoid unnecessary expense.

The valuation should ideally be approached as independently as possible, even by a staff valuer. The lending decision-takers should not seek to influence the valuer’s judgment in any way. This is especially important for building societies, which must comply with the specific requirements of the Building Societies Acts.

The risk decision should take full account of the recommendations in the valuation report, alongside the lender’s own experience of similar mortgaged properties. All these factors must, of course, be viewed alongside the assessment of status and ability to repay, considered earlier in this unit.

The valuer will provide a figure for the re-instatement value of the property, ie the cost of rebuilding in the event of total destruction. As far as the lender is concerned, this is the sum for which the property will be insured. There is no specific link between this figure and that for the valuation for mortgage purposes, or the price that the purchaser has agreed to pay. For most properties of standard construction, the re-instatement value will be rather less than the valuation for mortgage purposes. This is because the land on which the property is built is indestructible, whereas the value of that land is included in the overall value of the property.

A property of unusual design and constructed of non-standard materials, eg timber, may have a re-instatement value that is approximately the same as, or even higher than, the valuation for mortgage purposes. This reflects the likely higher cost of the non-standard materials.

All major property developments require consent by the local authority, as do a good many minor changes that individuals make to their homes.

It is most important to consider these at the application stage. All lenders ask whether substantial changes have been made to a property. If they have, documentary evidence should be sought to confirm that these have had full consent of the planning authorities.

Examples of matters requiring planning consent are:

This is not an exhaustive list: prospective purchasers should always ensure that the work they intend to do has the full sanction of the local authority. Likewise, it falls to the lender’s solicitor to ensure that the proposal will satisfy planning laws. If in doubt, the lender should seek specific guidance from the solicitor.

In addition to the need to comply with planning law, developers also have to be mindful of their responsibilities under the building regulations. These are not especially detailed, though they do cross-refer to various British Standards conventions. Local authorities have a discretion to overrule building regulation requirements in instances where they are clearly inappropriate.

Further advances are often made for home improvements, so it is necessary to ensure that the proposals by the applicant have consent before any advance is made.

As a matter of principle, local authorities are highly unlikely to grant planning permission retrospectively, so once a land owner makes changes to the property which have not been sanctioned, they are almost certainly going to be rejected later on. The importance of this is twofold. Firstly, if the borrower is instructed to tear down or remove the changes that have been made to a property, and put it back the way it was before, then it may be worth less money than it appeared to be when the advance was made – and so the lender’s position may be less secure. Secondly, and whether or not the removal of the feature reduces the property’s value, it is likely to cost money to actually make the changes. The borrower will need to find this money somewhere, and this may impact on his ability to service his mortgage.

The Building Regulations are contained in the Building Act 1984, which is applicable only in England and Wales. The majority of building projects must conform to the Regulations and their main purposes are to:

Building work covered by the Regulations includes:

Projects that are exempt from Building Regulations include:

Subsidence most commonly affects properties that are built on a clay soil and results from a drop in the water table after a long, dry spell of weather or because an excessive amount of water has been sucked out of the soil by trees and bushes. Subsidence can also be caused by water leaking into the soil over a long period of time. The telltale signs of subsidence include:

Although subsidence can usually be rectified, it may be that a property with a history of subsidence cannot be insured, and hence would not be considered a suitable security for a mortgage. Any evidence of past of present subsidence will be highlighted by a basic valuation. The valuer is likely to recommend that a specialist report be obtained before the mortgage application is approved and an offer of advance issued. Even if such a property is insurable as a result of past subsidence having been remedied, the proposed purchaser may well decide to withdraw and look for another ‘safer’ property.

Disputes between neighbours have become increasingly common in recent years. The causes of such disputes range from excessive noise and nuisance to disagreements over property boundaries, rights of way and problems caused by trees and bushes. The vendor of a property now has an obligation to disclose any such disputes with neighbours in the pre-contract information that is passed to the purchaser’s conveyancer. Such information may result in the proposed purchaser withdrawing from the transaction.

If a vendor fails to disclose details of any dispute with a neighbour, even if this has been resolved, he may be subject to legal action if the next owner of the property subsequently becomes aware of that dispute.

Section 4

Guarantees and additional security

Sometimes lenders are reluctant to lend solely on the basis of accepting the property as security for the loan. They require something more, and that something may be the support of a guarantor or surety.

A guarantor is someone (whether an individual, a company or occasionally a partnership) who agrees to be responsible for the repayment of a loan if the borrower cannot or will not repay it himself. He does this by making a guarantee, which is defined under the Statute of Frauds Act 1677 as a written undertaking to ‘answer for the debt, default or miscarriage of others’.

A surety, on the other hand, is a guarantor who, in addition, puts up some form of security for the mortgage. As well as making the undertaking to answer for the mortgage if the borrower fails to do so, he also provides some additional collateral.

Typically guarantees are taken from parents on behalf of their child’s borrowing. And frequently the directors of companies are asked to give their personal guarantees to secure a loan made to the company. This is because the loan is made to the company and not to the directors. It is enforceable only against the company, not its shareholders and normally not against the directors. To take guarantees ensures the directors also support the loan.

In some cases those who give guarantees are asked to support their guarantees with some form of security. For example, it may be their house or stocks and shares they own. As we have seen, this then makes them also ‘sureties’.

Lenders must exercise great care in how they take guarantees. On the one hand they want to be sure that they do all they legally can to ensure the guarantor pays. On the other they must be careful to prevent the guarantor being able to legitimately avoid the obligations entered into.

A major risk to guard against is that the guarantor argues that the guarantee is invalid because he or she did not receive adequate explanation of the terms or that undue pressure made him or her sign it. So without fail, lenders should advise guarantors to seek independent legal advice from their own solicitor and then to check that that has in fact been done.

Steps should be taken to ensure that prospective guarantors understand what they are taking on. This is important for the guarantor – who may find that they incur a substantial liability. It is also critically important for the lender, who will not wish to find that a guarantee on which it had been relying has been avoided for invalidity because the guarantor has managed to show that he was unaware of, or did not understand, what the guarantee meant.

There are a number of specific issues that can render a guarantee invalid, as follows.

This case led to the inclusion of a provision in the Banking Code whereby lenders agreed that prospective guarantors would be encouraged to seek independent legal advice before entering into a guarantor contract. This is now an established feature of lending practice in all cases where guarantors are involved.

If you have not already done so, obtain a copy of the Banking Code, and, if your organisation has one, its own summary document of its obligations under the Code, and familiarise yourself with the matters relating to giving advice to guarantors.

The guarantor is bound by contract for his obligation to pay the lender if required to do so on default of the borrower. The only way this can be avoided is if it can be established that the contract is invalid – brought about by misrepresentation or undue influence, for example.

The lender, therefore, has the right to enforce the guarantee should the borrower default in repayment. By contrast, the guarantor has few rights. A request can be made for release from the obligations of the guarantee agreement, but the lender will only agree to this if it is felt that the lending proposition is basically sound without it.

The lending institution has two ‘safety nets’ whenever it enters into a mortgage contract:

In the UK it is customary to offer relatively high percentage mortgages, often 90–95% of valuation. Some lenders even consider 100% loans in some circumstances. However, many lenders will only lend more than 80% of the property’s value if some form of additional security is made available.

Check to see if there are any circumstances under which your own institution will offer 100% mortgages.

Some life assurance policies accumulate a surrender value after a period of time in force. These typically include endowment assurances. Generally, endowment policies have no surrender value at all for the first, say, 18–24 months, but thereafter tend to increase in value as reversionary bonuses are added.

It is possible for a lender to take such policies into consideration as additional security. The method of taking a policy of assurance as security is by assignment. This is the legal method of transfer from the insured to the lender.

Some lenders take a deposit of the life assurance policy document rather than a deed of assignment, thus saving time. This gives the lender no legal right to the proceeds of the policy, but does create an equitable right. An equitable right is governed by the practice of equity, or fairness, and indicates an agreement between the two parties.

A collateral deposit is simply a sum of money placed with a lender, or an account assigned to a lender, used as additional security for a loan. The funds are effectively ‘frozen’ until the debt is repaid or until the debt is reduced to a level at which the additional security is deemed unnecessary.

Where that collateral deposit (or indeed security in any other form, such as shares, another property, etc) is put up by someone other than the borrower, then as we have earlier noted, the depositor will be known as a ‘surety’. It is beyond the scope of this text for us to consider the mechanics of how the lender would perfect his security over the assets. However as you would expect there are fairly standard procedures which generally give the lender recourse to the collateral without reference to the surety, should the borrower default and the need arise.

The fees and charges relating to buying a house have been covered in the appropriate sections of this manual. However, it is useful to include a summary here.

The main fees involved in buying or selling property are outlined below.

Estate agent’s fees are paid by the vendor once the sale has been completed, and typically amount to a figure between 1.5% and 3% of the sale price, depending on whether the agent has sole selling rights or a joint agency. Most agents have a no sale, no fee agreement.

Typical costs for a £250,000 property are:

Valuation only – £250–£300

Homebuyer’s report – £450–£550

Full building survey – £600 or more, depending on the size and age of the property. The price of the property is relatively unimportant.

Valuations and surveys are not refundable once completed.

Legal fees are difficult to quantify as they are affected by a variety of factors. Typical activities generating charges are as follows.

Stamp Duty Land Tax replaced Stamp Duty on property from December 2003. It is largely a technical change, in that Stamp Duty is a tax levied on the transfer documents, whereas Stamp Duty Land Tax is levied on the physical transfer of the property. Stamp Duty Land Tax is paid by the purchaser of a property on transfer from the vendor. The tax is calculated on the full price of the property.

The tax is levied on a sliding scale, determined by the sale price of the property. The rates are:

Where the loan-to-value ratio exceeds a certain level, the lender may charge a higher lending charge. The charge threshold varies from lender to lender but is usually between 75% and 90%.

The lender may use the higher lending charge to buy an insurance policy called a Mortgage Indemnity Guarantee (MIG), which protects the lender in the event of a property being taken into possession and sold for less than the outstanding debt. Although the charge is paid by the borrower, the Mortgage Indemnity Guarantee does not actually benefit him, except that without it he would not be able to borrow such a high amount.

Some lenders do not buy an insurance policy, but take the charge as a way of offsetting the potential risk.

Some lenders will allow the charge to be added to the advance rather than being paid up front. In recent years, more and more lenders have either dispensed with higher lending charges or paid the Mortgage Indemnity Guarantee themselves. This is one of a range of incentives that lenders make available to attract new business.

If a claim is made by a lender on a MIG policy, the insurer is entitled to exercise its right of subrogation, ie to sue the borrower for recovery of the amount paid to the lender. For many years MIG claims were almost unheard of. However, when lending policies were relaxed in the 1980s, followed by a substantial fall in property values, claims became more commonplace.

This situation led to discussions between lenders and MIG insurers resulting in the Association of British Insurers (ABI) issuing guidelines in respect of the handling of claims. These guidelines allow insurers to insist that lenders adopt certain mortgage underwriting standards before policies are underwritten.

If a lender sells a property in possession for £120,000 but the total owed by the former borrower is £130,000, then the claim made by the lender on any MIG would be for £10,000. The insurer will probably sue the borrower under its right of subrogation for the £10,000 that it has paid to the lender.

A mortgage applicant is hoping to borrow £72,000 to purchase a property priced at £84,000 but valued at £80,000. The lender requires a higher lending charge if the loan-to-value ratio exceeds 80%.

The higher lending charge threshold is £80,000 x 80% = £64,000

The amount of the advance to be covered by the charge is therefore

£72,000 – £64,000 = £8,000.

If the higher lending charge rate is 4.5%, the premium will be

£8,000 x 4.5

––––––––––––– = £360

100

Higher lending charges are clearly designed to offer lenders some protection in the event of the default of a mortgage borrower: but this protection is not unlimited and not without its conditions. For example, we have noted that many (although not all) higher lending charge insurance providers require that the lender pay an ‘excess’: this excess is normally calculated as being the first 20% of any claim made under the cover. A variation on this might be where the insurer requires that the lender pay an excess – but only in certain specific circumstances. In addition, lenders must stay within strict underwriting criteria to be able to claim under the higher lending charge. As a consequence of these two factors, lenders have a powerful incentive to be disciplined in their lending behaviour: the higher lending charge is not a complete safety net, nor a substitute for sound lending principles.

Because of its limitations, and because of the fact that higher lending charges can seem difficult to justify to the borrower, some lenders are phasing out their use (and, arguably, substituting more rigorous lending criteria). This trend has been exacerbated by the difficult lending conditions that followed the property boom in the 1980s, and by the stricter criteria and higher premiums demanded by the insurance market. Other lenders, rather than requiring that the borrower fund the premium, are now footing the bill themselves (especially in cases where the loan-to-value is below a specified level): and still others are (as we have noted) establishing their own captive insurers which provide tailored in-house higher lending charge cover.

Section 5

From offer of advance to completion

If, having reviewed a prospective borrower’s application, a lender decides that the loan is viable, the next stage is for him/her to tell the applicant this – and the terms on which he/she is prepared to lend. This is done by way of an offer of advance or offer letter.

An offer letter is not itself the final legal contract – this comes later. Rather, the offer letter is worded in such a way as to be an invitation to treat: an invitation to the applicant to enter into an agreement, rather than the agreement itself. However, the offer letter will contain many of the details that will also eventually be reflected in the mortgage contract.

Offer letters are generally issued ‘conditionally’: that is, they are not binding on the lender unless and until the applicant fulfils the conditions set out. An offer may be withdrawn if:

The lender will generally send one copy of the offer letter to the applicant, and another to the solicitor who is acting for him on the transaction. Offer letters are highly standardised, and a typical one will contain:

We will look at each of these in order.

The general details the offer letter will contain are as follows:

The Standard Warranties and Conditions contained in the offer letter include:

In addition to these standard conditions, an offer may also be subject to certain specific conditions.

* An ‘overriding interest’ is a right established in favour of the occupants of a property who are not a party to the mortgage, but who nevertheless have an interest in it. Such interests were originally established under s 70 of the Land Registration Act 1925 so as to prevent hardship and unfairness on (for example) non-owning spouses who could be severely disadvantaged if the owning spouse was to default on the mortgage, leaving them homeless. The range of those who can establish overriding interests has widened considerably over the years to include a number of people other than the borrower’s spouse. The practical relevance for a lender is that it is important to be aware of who the potential occupants of a mortgaged property, other than the borrower, are. Otherwise, if the lender has to take over the property in the event of default, he could have difficulty getting vacant possession quickly. This may considerably delay any sale of the property and realisation of the security.

If, on receipt of the offer letter, the applicant wishes to proceed on the basis of the terms set out in it, he will complete it and return it to the lender. At the same time his solicitor will be liaising with the seller’s solicitor to agree terms for the sale.

Should all go to plan, the applicant now knows that subject to his being able to meet all the conditions, the lender will make funds available to him. The next step is for contract terms to be agreed with the seller, and for the buyer’s solicitor to carry out all the relevant searches.

Once these stages are complete, signed contracts are exchanged between seller and buyer and at this point a non-refundable deposit is generally paid by the buyer to the seller. At this point both parties are committed to the transaction and the buyer also becomes responsible for insuring the property. Between exchange of contracts and completion – the actual handover of the property – the lender will prepare the mortgage documentation, which is what we will look at next.

Before a lender enters into a binding contract with a borrower, it will insist on receiving a satisfactory report on title: the solicitor arranging this will make any additional observations which he thinks may be relevant. The report on title will confirm the borrower’s full name as it will be recorded in the legal documents, and show the outcome of the various searches on title which the solicitor has undertaken; (you will remember that we looked at these in Unit 3 at Section 3.2 (The role of the solicitor and conveyancing principles).

If the title to the property is not free from defects, the solicitor must advise how these affect the security and/or how they may be overcome (eg is more legal work needed to overcome the problem. Could insurance cover be arranged?).

Essentially the lender wants to know that the property can safely be taken as security for the loan.

With some legal matters, rather than incur the additional costs and delays in investigating the matter further, it may be possible to arrange some kind of Defective Title Indemnity Policy that protects the lender against future losses that may occur as a result of the legal defect.

The process of investigating title is becoming progressively more straightforward as land registration is compulsory in England and Wales as well as in many areas of Scotland. This is because registration of details of the property, ownership and incumbrances affecting the property are guaranteed to be accurate.

Some lenders are now arranging Title Insurance policies on mortgages which reduce the amount of legal work that needs to be undertaken, and simply provides insurance cover to protect the lender against any losses that might occur as a result of the full legal work not being completed.

This means the necessary legal work can be reduced enabling the purchase, and the mortgage, to be completed more quickly. The borrower may also benefit from reduced costs.

However, while the Title Insurance policy will indemnify the lender against specified title defects, the borrower will need to satisfy themselves as to their own position in the event of any defective title problems.

You should have your own company’s legal charge, standard security and mortgage conditions available to read alongside the contents of this section.

A legal charge is the main way of creating a mortgage in England and Wales. In Scotland, a standard security is used. The charge is created by deed. The deed often contains a set of mortgage conditions, to which the borrower is bound from the time the deed is signed.

The deed is a formal and binding contract between mortgagee (lender) and mortgagor (borrower). Its contents and those of any document ‘linked’ to it (such as the mortgage conditions) cannot be varied without the consent of both parties to the contract.

Although the methodology is rather different in England and Wales from that in Scotland, the principles relevant to mortgage advisers are broadly similar.

Under the FSA’s Mortgage Conduct of Business Rules, lending institutions must undertake to make conditions of mortgage clear to borrowers. Even if this were not the case, they would have such obligations under the Unfair Terms in Consumer Contracts Regulations 1994. It is refreshing to note that since these regulations were passed (following passage into law of an EU Directive) several lenders have been commended for the effectiveness of ‘plain English’ documentation.

The lender will only release moneys to fund the mortgage when he is certain that all necessary conditions have been met and safeguards are in place. This involves checking that the report on title is consistent with the application details. If everything is in order, the advance cheque is sent to the solicitor in time for completion. The solicitor confirms the date of completion, enabling the lender to assume that completion will take place on the date specified and that this will be within a few days of the date of receipt of the cheque.

These are made when a borrower wishes to fund a self-build project. Stage payments involve splitting the loan into tranches (or separate amounts) progressively released as the project advances. Most lenders offer stage payments in three or four parts, depending on policy. Stage payments can also apply if a small builder is building two or three new properties only. Larger developers would not require stage payments.

Self-build is more common in certain areas of the UK than others. It is a highly cost-effective way of acquiring a dwelling that can save up to 25% in comparison with buying an existing house. Nevertheless, it remains a niche activity, probably due to the complex procedures involved.

Matters of concern to lenders in respect of self-build projects are:

In addition to first mortgages, it is possible for ‘further advances’ (which we will look at in a later unit) to be released in stage payments. This would generally be where the further advance is for a substantial amount and the borrower needs to make stage payments to the builder as work progresses.

On completion, if not before, details of the repayments required are sent to the borrower together with any other relevant information such as insurance details, direct debit forms and so on.

The mortgage deed (also referred to as the legal charge) contain the following:

The deed may also contain all the conditions of the lending contract: alternatively it may be a shorter summary, making reference to conditions contained in a separate booklet (mortgage conditions are highly standardised and so lend themselves to this treatment, with a pre-printed booklet containing all the conditions to which lender and borrower are bound). The conditions will include the following.

Consolidation occurs when one borrower has different mortgages on different properties with the same lender. If the borrower wishes to redeem one of these, the mortgagee can insist on redemption of all. This was excluded by the Law of Property Act unless a contrary intention is set out in the mortgage deed. Most lenders would reserve the right to consolidate.

For example, consider the case of borrower Mr Smith, who has mortgages on two properties with Lending Bank plc. Property A’s value is well in excess of the sum which Lending Bank has lent against it, while Property B has fallen in value to below the amount lent against it.

Mr A might, if he only had sufficient money to redeem one of the loans, be keen to pay off the one on property A (because he has some valuable equity in it). However, Lending Bank is not likely to be happy at being left with only a poorly performing loan against a property that now represents inadequate security. Consolidation provides a mechanism for the bank to protect itself against the borrower behaving in this way.

Legally, Lending Bank can consolidate if:

In practice, whether or not the lender decides to consolidate will be determined by its overall perception of risk, including conduct of the mortgage accounts and other business relationships with the borrower. A lender must be reasonable in its decision whether to consolidate or not.

The mortgage deed contains the conditions that bind both lender and borrower: where the borrower fails to meet these conditions, whether by defaulting on the loan or otherwise, there are a variety of legal remedies available to the lender. We will look at these in a later Unit when we consider the action that might be taken should things go wrong.

While it is the role of the solicitor to deal with the technicalities of the contract and the sale process, the mortgage adviser has an important role in guiding the borrower at application stage. As stated earlier, a mortgage is a very serious financial commitment, and likely to be one of the largest in a lifetime. The borrower has to be made aware of the significance of most of the conditions.

For example:

Most borrowers simply want to be assured that the conditions of mortgage are reasonable and that there are no ‘nasty shocks’ in store during the life of the lending arrangement. Having said this, consumers of financial services have become much more financially aware in recent years and are more likely nowadays to ask searching questions in order to get the best deal possible. The adviser, therefore, needs to be able to address the issues raised with confidence.